The method or process of trading futures contracts has remained virtually the same since the markets first opened in the 1800's. Use of state of the art technology in present systems has been limited thus resulting in major inefficiencies and opportunities for abuse. The futures trading system and markets, as they exist today, are the remnants of an archaic system. When an investor (hedger or speculator) wishes to trade on any of the futures exchanges, he is many times removed from access to firsthand trade data unless he is a floor trader. He must first call his broker who may have a direct line to a floor clerk but, generally, must call the trading room of the broker headquarters. The trading room calls the floor clerk who in turn relays the information to a runner. The runner relays the request for information or execution of a trade to the floor trader. The floor trader stands in a "pit" and executes a trade by shouting out his offer to sell, or buy, until someone across the pit signals that they will take the offered price (bid). When a trader thinks he has made a trade, he marks a trading card and a portion of the card is given to the exchange to begin the clearing process or accounting and funds collection process. This is known as the "open outcry" system because trading takes place in a central location in open view of a variety of participants. Most exchanges require that the trader enter the trade within one-half hour of the time a trade has been executed.
As can be imagined, there are many problems with the present archaic system. The markets were originally designed when there were a relatively few number of people who wished to participate in the process. As the number of participants have increased, it has meant that those who are directly on the floor of an exchange are at a distinct advantage over those who are not physically present. First, when a customer asks a question as to what is taking place, the question is relayed through four or five people. An answer to a question is at most subjective because it is based on the observation of those who are on the floor. The floor trader will tell what he thinks is happening but he does not have the tools to be sure that his observation is correct. The advantage that a floor trader has is that if his observation is not correct, he can make an additional trade to correct the situation for himself. But a retail broker or customer may not be advised of a change and at worst may simply be given inaccurate information.
The opportunity for mistake or abuse has been acknowledged by regulators and exchanges alike. As the system presently exists, trades are not confirmed until after an exchange is closed for the day. Therefore, if a floor trader has traded in front of a customer in order to obtain a better price or has failed to execute a trade for fraudulent reasons, it is difficult to detect. Even when a trade has been properly executed the opportunity for abuse or mistakes is still high as will be discussed hereinafter.
On a traditional exchange, after a trade is made a card is handed to an exchange employee who then keypunches the data into the computer. At the same time trading cards must be manually sorted to match trades. At the end of the day the computer lists are checked against the trading cards to reach agreement as to the trades which have been made. As can be well understood, there, first, may have been a mistake in the keypunching process. Secondly, there may be a difference given in the two cards as to the price at which a trade was made and thirdly because the trades are based on eye contact, there may be a difference in opinion as to whether a trade was actually made at all. When there is disagreement, a list of "out trades" is made and agreement must be reached as to whether the trade was made at all and if so at what price. The nature of the discrepancy determines whether the trader, the broker, or the customer must bear the cost of an out trade. Again, because the customer is at a lengthy distance, he is at a disadvantage because he takes no part in the resolution process.
The accounting process also has its problems. Once the matching of trades takes place, the information is fed into the clearing process of an exchange. The present clearing process in most exchanges is a computerized process. However, since information is manually entered, after the fact of the trade, its value lies only in the accounting process and not in the control of the exchange process. The exchange only knows at the end of the day if a trader has exceeded his position limits or has incorrectly identified a clearing member or has provided other incorrect information. On most exchanges 300 to 400 individuals are required to process trading cards and complete the clearing function.
The surveillance of the system as it now exists (to insure proper operation and minimize mistakes and abuse) also has numerous problems. Surveillance is completed on existing exchanges through live observation. An exchange employee stands in the middle of a ring and observes trading as it takes place. With close to a 1,000 people on the floor of an exchange, observation is spotty at best. Some exchanges have programs for detecting illegal trade practices which are repetitive but even when such practices are detected often the information available as evidence is inaccurate and unreliable.
The present invention, the automated futures trade exchange, has created an entire automated process for trading futures contracts which provides accurate and precise information, trading based on factual data, assurance of execution and immediate confirmation of the contracts, control through real time processing of information and electronic surveillance, and the use of computer hardware to implement the process. It does not separate clearing and surveillance from the futures trading process as do other exchanges because it is the combined process which allows the markets to function properly.
All trading conducted on the automated futures trading system will be effected through a central computer complex programmed to handle orders for the exchange's futures contracts. Access to this central computer will be available only through specially programmed remote computer terminals which will be distributed only to exchange members who will have a coded membership number. Each remote terminal will consist of a keyboard, a printer, on-line storage and a video monitor, the latter displaying a variety of information regarding the futures contracts traded on the exchange. Members will be able to utilize these terminals to transmit to the central computer bids and offers for their own accounts as principals or for the accounts of customers for whom they are agents. However, the system does not allow direct negotiations between members of the exchange as in the system disclosed in U.S. Pat. No. 3,573,747. Instead, the system acts as an intermediary among members and matches bids and offers and completes the transaction. Thus, the present novel system is an open outcry system since trading takes place in a central location in open view of a variety of participants.
When an order is transmitted to the central computer, its pertinent characteristics will be recorded including quantity, price, the time that the order was placed, and the capacity in which the order is entered; that is, whether as agent or principal. The exchange central computer will retain all orders received, arranging each bid and offer on the basis of its price, quantity and entry time and displaying all bids in descending order of price and all offers in ascending order of price. Thus, each bid or offer will become part of the market data displayed in every member's remote terminal video monitor. The breadth of the market will also be indicated. That is, whether a bid of 200 contracts represents one offer to buy 200 contracts or 20 offers to buy 10 contracts.
In addition, the video monitor of each remote terminal will display lot sizes, last sale prices, daily price ranges, the volume for each contract month, the spread relationships or price differential among the various contract months, and allows simultaneous spread trades (both in time and by commodity) to take place.
Pertinent to this process is the capability to modify prices at a remote terminal by moving a cursor on the video display to the bid or offer desired to be modified by the user which modification is then accomplished through the keyboard. The capability to see the display of buys and sells is analogous to the open outcry system of trading and is pertinent to good trading because it shows the supply and demand in the market. On the floor of an existing exchange, a trader would have a "feel" for the market but would not be able to relay to a customer with any degree of accuracy information pertaining to the distribution of bids and offers.
The exchange central computer will automatically match equal bids and offers on a first come, first served basis thereby executing the transaction. Each transaction execution will be immediately confirmed to the members on both sides of the trade by the printing mechanisms of those members terminals. Each execution report will include information regarding the date, time, quantity and price of the transaction. The exchange central computer will be able to handle a full array of futures orders including straddles, limit orders and stop orders. Because bids and offers are transmitted from the remote terminals directly into the computer there will be no chance for an "out trade", that case where a trade is made but the bid and offer do not match. Moreover, because trading will be effected solely by the computer, a record will exist of the precise time each order was entered, the precise time it was executed and the precise time an execution report was transmitted.
Another important factor in trading is the capability to determine the liquidity of the market. Again, on the floor of an exchange a trader may note that trading is active but by the time information is relayed back and forth between the principal and the trader the price may have moved considerably or the bids and offers may no longer be present. No presently existing exchange can determine with accuracy during the trading the volume of trading immediately taking place. The present system will record trades exactly as they are made, when they are made, and thus a member would be able to determine the volume of trading taking place at any particular time and would have the information necessary to determine whether it is likely that he can come in and out of the market at his desired price level.
Each terminal on the system will be specifically designated to trade a certain number of contracts. Position limits for each principal are thus determined by the fiduciary capabilities of the participant. Under the present system of trading on exchanges, a member may execute trades far in excess of his limit without detection by the exchange. In the present trading system, limits will be programmed into each individual terminal thus further eliminating the possibility of "out trades" because an individual trader has exceeded his limits. During trading times live surveillance of the market will take place through control terminals at the exchange. Information may be fed directly into the surveillance system to detect the patterns of trading which may be manipulative and since all information is recorded as trading takes place, accuracy is assured.
All information from the trading system will be moved directly to the clearing system. Thus, there is no manual matching of trades and accuracy of the data is assured. Earlier and more rapid transfer of funds will be possible thus increasing the financial viability of the exchange as a whole.
It has been recognized for some time in the futures industry that multiple factors determine the pricing of commodities. Thus, the use of computerized analysis has rapidly developed and multiple tools for graphing and receiving information has been developed. But the process for trading and processing trades remains archaic. The present system provides a means of executing trades, validating the information, and notifying parties of pertinent changes without bias to those who participate. Thus, a larger more efficient marketplace may be accommodated at lower cost.